Short-term rentals are a topic that is just buzzing with excitement and opportunity these days! Many real estate investors typically devoted to year-long lease agreements are seeing bigger profits partnering with companies like Airbnb and Vrbo.
But as it is with all investments, higher earnings also come with higher risks. There are several strategies that will allow you to take advantage of the short-term rental opportunity and avoid the land mines in the process, so let’s get into the details.
What are some of the benefits?
Short-term rentals provide a completely different set of benefits compared to those of long-term rentals. Now, remember, this doesn’t mean one is better than the other, in fact, having a portfolio of different types of rentals is always advisable.
- Your income should increase. Lots of my clients have been able to double or triple their rental income with short-term rentals. For example, an average long-term residential rental might collect $1,500 per month in rent, but with a short-term rental strategy, they are able to rent it out for $200 per night. With a conservative estimate of 15 rental nights per month, that’s already $3,000 in rent, doubling the prior gross rents. With a rental in the right area, the rental cost per night and frequency can create exponential cash flow unequaled with a long-term renter.
- It is available for personal use. Perhaps one of the best parts about owning a short-term rental property is that you can use it yourself! I have lots of clients that set up rental properties with Vrbo or Airbnb in an area they like to visit, and when they’re not using that property for themselves, they rent it out. Then, when they want to vacation at the property, they already have a place to stay! The property cash flows with short-term renters and now you’ve got a vacation home that costs you absolutely nothing. You’re paying down the mortgage and getting tax benefits, as well as the use of the property.
- Tax Benefits and NO rent payments. You don’t have to pay rent to yourself when you visit your own property. In fact, every trip and visit becomes a tax write-off because you need to check on it. When you stay at your property, you’re going to do checkups, repairs, re-paint something, clean or replace something. In other words, you’ll do something to make that rental property a little better and generate a deductible business trip in the process.
- You can often get a higher appraisal. When you get a residential property valued, an appraisal typically only looks at the fair market value of the “comps” in the area, but with an income property they will often also use the ‘income approach’. Otherwise stated, you can show that this property is making money and it’s worth even more because it’s an income property.
- Low capital entry in certain circumstances. I have some clients that find property that’s up for rent, sign a year lease, make sure in the provisions that they can sublease it if they want, pay their deposit, make sure there are no pets, etc. Then, they turn around and drop it in a Vrbo. We call that the sublease short-term rental strategy. You can sublet it on a short-term rental, even though you signed it on a long-term lease.
What are the risks and drawbacks?
Just as there are unique benefits with short-term rentals, there are also unique challenges and risks. It’s important that an investor planning to utilize this strategy study and truly learn the issues to consider and research the area closely before making an offer on a property.
- Local legislation in the municipality or city. Investors must be aware of whether the municipality or city your buying in will allow you to own a short-term rental property in that specific location. More and more cities are restricting short-term rentals and even charging the same tax rates a hotel or motel may charge. Do your research and look to what potential legislation may even be ‘in the works’ in the area. Just because there isn’t a law restricting or taxing your project currently, it could change dramatically in the future.
- You need to furnish the place and keep it updated. In order to make your property attractive, gain good reviews and keep it rented on a regular basis, an investor needs to outfit it with up to date furniture. The style of the furniture can be unique to the property or geographical area, but it certainly needs to be in good condition and durable enough to handle renters day in and day out. You should keep a reserve for updating different furniture on a regular basis.
- Marketing is key. You’ll need to do whatever it takes to make the place attractive and desirable to renters. This is rarely the case with long-term rentals, but with short-term rentals an investor needs to think ‘outside of the box’. This is a destination or vacation for your guests and they want to have an ‘experience’. The little things to make the rental nice go a long way and reviews are absolutely critical. Do whatever it takes to resolve problems and garner 5 Star Reviews whenever possible.
- Market volatility. This is one of the biggest risks of short-term rentals. Generally speaking, If the economy is doing well, short-term rentals do well. If your short-term rental is barely breaking even in peak seasons or when the economy is booming, just know that it can get ugly real quick. But it doesn’t mean all is lost. Simply convert the property to long-term, or even a lease option, work to have it cash flow and then find a different and better property for your short-term strategy.
- Awareness of the competition is critical. You need to take the time to check on other short-term rentals in the area. Do your best to estimate their number of rental nights per month, their availability and nightly rates. What do you estimate your competition is bringing in per month with their properties? There may be 50 other Airbnb’s in the area. Determine what you can do to make yours better! What will set your property apart? If you can’t beat the competitors don’t crash the party. Be a bigger fish in a smaller pond and do your investing somewhere else.
- Know the tax rules and how it could affect your bottom line. It’s not as straightforward as you may think. See below for more on the special IRS rules in regards to short-term rentals.
Who should consider investing in a Short-Term Rental?
Those typically buying monthly/long-term rental properties may find the short-term rental market attractive to diversify their portfolio. As I stated above, the ROI could be better with a short-term rental, but the risk and volitility could in turn be higher.
However, those without a lot of capital to spare in a traditional acquisition may find the sub-lease strategy an attractive option. This entails leasing a property under a traditional lease arrangement where you may only be out the first and last month’s rent with a traditional deposit. Then (making sure your primary long-term lease allows), you list the property as a short-term rental with Airbnb, Home Away or Vrbo and create cash flow from the short-term rentals. If executed properly, there is plenty of cash flow over and above utilities and the long-term lease.
Next, retirement plans are also getting into the fray. Your IRA, Roth, 401k or HSA can invest in short-term rentals and far exceed the returns of a mutual fund or ETF. The process involves first transferring your ‘retirement account’ to a Custodian or Trust company (such as www.directedira.com) that allows for ‘self-directing’ and then forming an LLC owned by one or more retirement accounts of your choice. You can manage the LLC, but need to use a third party to manage the property or do repairs and improvements. Here is a video with the basics on how to get started using your retirement account to purchase rental property:
If you are (or are thinking about becoming) involved in the hot short-term rental industry, these are issues you need to be planning for and facing head-on. Please make sure you are getting the advice of a qualified and experienced professional.
* To sign up for Mark’s weekly Free E-Newsletter and receive his Free E-Book “The Top 10 Best Tax Saving Secrets Everyone Should Know” visit www.markjkohler.com.
Mark J. Kohler is a CPA, Attorney, co-host of the Main Street Business Podcase and author of the new book “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP.